Cryptocurrency Taxation and Divorce: Guidance for Canadian Taxpayers

Posted on by Tax Partners
Canadian Tax Return
30
Dec

Introduction – Cryptocurrency and NFTs as Matrimonial Property

Divorces often result in significant financial changes, with the division of matrimonial property being a central concern. As investments in cryptocurrency and non-fungible tokens (NFTs) continue to grow, these digital assets have increasingly become part of the property division process.

This article explores how cryptocurrency and NFTs are treated during a marriage breakdown, reviews the tax consequences of their disposition, and highlights the importance of complying with Canada Revenue Agency (CRA) requirements for reporting foreign assets. Practical tips are offered for taxpayers, including how to leverage voluntary disclosure to rectify reporting errors.

Cryptocurrency and NFTs: Disclosure Obligations During Divorce

Cryptocurrencies and NFTs are financial assets and must be disclosed in the event of a marriage breakdown. Failure to disclose these assets can result in penalties, as seen in M.W. v N.L.M.W., 2021 BCSC 1273, where the British Columbia Supreme Court penalized a husband for failing to provide accurate cryptocurrency disclosures. Despite claiming significant losses, the court attributed $60,000 to his cryptocurrency holdings, underscoring the necessity of full disclosure.

Transferring Cryptocurrency Between Former Spouses Without Tax Liability

Under section 73(1) of Canada’s Income Tax Act, capital property (including cryptocurrencies and NFTs) can be transferred between former spouses or to a spousal trust without triggering income tax, provided these conditions are met:

  1. The property is classified as capital property.
  2. The transfer is part of the marital property settlement.
  3. Both parties are Canadian residents at the time of transfer.

This automatic tax-free rollover eliminates the need to file any election or form with the CRA. If the transferor elects out of the rollover, any resulting capital gain or loss must be reported in their tax return.

Taxation of Gains from Cryptocurrency or NFT Dispositions

Once transferred, the recipient spouse assumes the transferor's adjusted cost base for the assets. Upon subsequent disposition, the recipient will be taxed on any gains or losses. How these gains are characterized—as business income or capital gains—has significant tax implications.

  • Business Income: Fully taxable.
  • Capital Gains: Only 50% is taxable.

Courts and the CRA assess several factors to determine whether a disposition constitutes business income or a capital gain, including:

  • Nature of the property: Was the property intended for income generation or personal enjoyment?
  • Duration of ownership: Short holding periods often indicate business transactions.
  • Frequency of transactions: Frequent trading suggests business activity.
  • Effort applied to the asset: Actions taken to improve the asset’s marketability may classify it as business income.
  • Intention at acquisition: The taxpayer’s primary and secondary intentions are critical in determining tax treatment.

Reporting Foreign Cryptocurrency or NFT Holdings

Cryptocurrencies and NFTs held abroad are classified as "specified foreign property" under the Income Tax Act. Taxpayers with foreign holdings exceeding $100,000 CAD at any time during the tax year must file a T1135 Foreign Income Verification Statement.

Failure to file T1135 can result in severe penalties:

  • Basic Penalty: $100 or $25/day, up to a maximum of $2,500.
  • Gross Negligence: $1,000/month, up to $24,000.

Foreign holdings used exclusively in an active business may be excluded from this requirement.

Voluntary Disclosure Program (VDP): A Second Chance

Taxpayers who fail to meet T1135 reporting obligations or have unreported cryptocurrency gains can use the CRA’s Voluntary Disclosure Program (VDP). The VDP allows taxpayers to rectify errors and avoid penalties, provided these conditions are met:

  1. The disclosure is voluntary (i.e., not prompted by CRA inquiries).
  2. The disclosure is complete.
  3. Penalties could have been applied.
  4. The information is at least one year overdue.
  5. Estimated taxes owing are paid.

While the CRA reviews each application individually, the VDP provides substantial relief to compliant taxpayers.

Pro Tax Tips: Reporting Cryptocurrency Gains and Avoiding Errors

  • Accurate Reporting: Always disclose cryptocurrency or NFT holdings during divorce proceedings.
  • Characterization of Gains: Consult with a tax professional to determine whether gains are business income or capital gains.
  • Record Keeping: Maintain detailed records of cryptocurrency transactions, including valuations, transaction IDs, and purposes.
  • Timely Filing: File the T1135 form on time to avoid penalties.
  • VDP: Use the Voluntary Disclosure Program to address prior errors without penalties.

FAQs

  1. Are capital property transfers between former spouses taxable?
    No, capital property transfers between former spouses are tax-free rollovers if specific conditions are met.
  2. When is the T1135 form due?
    For individuals, the T1135 is due by April 30 of the following year. Corporations and certain trusts may have different deadlines depending on their fiscal year-end.
  3. What relief does the VDP offer?
    The VDP offers two streams:
  • General Program: Penalty-free with 50% interest relief for older assessments.
  • Limited Program: No gross negligence penalties, but no interest relief.
  1. How are gains from cryptocurrency dispositions taxed?
    Gains may be taxed as business income (fully taxable) or capital gains (50% taxable), depending on factors such as intent and trading frequency.
  2. What happens if I fail to file the T1135?
    Penalties for late filing range from $100 to $2,500, with higher penalties for gross negligence or willful non-compliance.

Conclusion

As cryptocurrencies and NFTs become integral to modern financial portfolios, they increasingly intersect with family law and tax compliance. Full disclosure of these digital assets is crucial during divorce proceedings, not only for equitable division but also to avoid legal and tax complications. Proper characterization of gains and timely reporting of foreign holdings are essential to meet CRA requirements.

Canadian taxpayers navigating these challenges are strongly advised to seek guidance from experienced accountants specializing in cryptocurrency and matrimonial taxation to ensure compliance and optimize tax outcomes.

This article is written for educational purposes.

Should you have any inquiries, please do not hesitate to contact us at (905) 836-8755, via email at [email protected], or by visiting our website at www.taxpartners.ca.

Tax Partners has been operational since 1981 and is recognized as one of the leading tax and accounting firms in North America. Contact us today for a FREE initial consultation appointment.

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